A true contrarian look at investing and at life in general.
WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint once or twice each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.
TWO SHARP DOWN DAYS FOR GLOBAL EQUITIES LIE DEAD AHEAD (August 25, 2009): While stock markets worldwide have been struggling to make nominally higher highs, the frequency and intensity of negative divergences have been increasing notably in recent weeks. These include all of the following:
1) TLT, a fund of U.S. Treasuries averaging 25 years to maturity, has been forming a classic bullish pattern of higher lows since it touched an important nadir on June 10-11, 2009. At that time, TLT had slumped to its lowest point since October 2007 and was trading with unusually high volume, as is characteristic of a critical intermediate-term bottom. What's bullish for U.S. Treasuries is bearish for the stock market, since this indicates that the most knowledgeable investors have been shifting from a desire for increased risk to a quest for safety.
2) VIX, which measures the implied volatility of a basket of options on the S&P 500 index, has been forming a pattern of higher lows since July 24, 2009, when it completed a ten-month intraday bottom at 23.00. A rise in implied volatilities even when the stock market has been strong, especially when combined with a simultaneous rise for U.S. Treasuries, is signaling that the recent amateur surge into the stock market is about to lead to a convincing reversal.
3) Traditional leading equity indicators including semiconductor shares (SMH), high-yield corporate bonds (HYG), and gold mining shares (GDX) have recently been underperforming the broader equity market. For several decades, each of these sectors has been a reliable leading indicator for the S&P 500. With all three simultaneously showing signs of exhaustion, a sharp equity correction has become increasingly imminent.
4) A significant percentage of those who sold near the 13-year low in early March of 2009 have been buyers in recent weeks. They were wrong then, and they're going to be equally wrong now. Many of the same "market-timing" analysts who have been consistently on the wrong side over the past two years have recently switched from being bearish to being bullish. Media coverage of the stock market is the most positive since the summer of 2008.
5) Too many investors project the recent past into the indefinite future. From September 2008 through April 2009, we had numerous sharp down days for the S&P 500; since then, we have had no such intense one-day pullbacks. The likelihood that we will therefore get two daily declines averaging 4%-5% apiece has sharply increased just when investors' expectations of such a possibility are at a minimum. The fewer the number of people who are prepared for any given event to occur in the financial markets, the more likely it is to happen.
I continue to recommend buying VXX as the best way to capitalize on any imminent stock-market pullback, since VXX is likely to gain more than one third in value over the next several weeks.
Once TLT reaches a peak near 103 and begins to form a pattern of lower highs, probably in September 2009, this will signal that the upcoming global equity correction is complete, and is about to lead to the next stage of the powerful worldwide equity bull market which will likely achieve its ultimate peaks in January and/or February of 2010. It will be critical to sell all of your stocks and corporate bonds this winter, as we will commence a severe bear market at that time of roughly two years in duration. This bear market will result in the S&P 500 bottoming at least one third below its March 6, 2009 nadir of 666.79.
INVESTORS ARE IGNORING NUMEROUS POSITIVE EQUITY DIVERGENCES (March 8, 2009): There are numerous positive divergences in the global equity markets which are pointing the way toward the strongest short-term stock-market rally since the Great Depression. Let's examine each of them to more fully understand their profound significance.
The first and most important divergence is the recent collapse in government bonds worldwide, including U.S. Treasuries. Long-dated U.S. Treasuries, such as the fund TLT, have been collapsing since they completed a historic peak on December 30, 2008. Very few individuals trade Treasuries; this sector is primarily the domain of major institutions and pension funds. The flight out of Treasuries represents a decisive shift away from safety toward risk and signifies a clear rejection of the "deflationary depression" hypothesis. If the global economy were really set for a major contraction, money would be flowing into government bonds instead of out of them. Therefore, the global economy is set for a major expansion.
Another important divergence is the U.S. dollar index recently forming a pattern of several lower daily highs after having reached a three-year zenith. During times of economic stagnation, the greenback is a nearly perfect inverse indicator: when the U.S. dollar is rising, this indicates that the global economy is contracting, and vice versa. The fact that the U.S. dollar index has been starting to move tentatively lower shows that the most knowledgeable global traders are beginning to position themselves in favor of economic expansion--thus confirming the message of global government bonds.
Yet another divergence can be seen in the strong performance of global commodity-producing shares since October/November 2008. Gold mining shares have more than doubled in value since October 24, 2008, as can be seen in a chart of GDX and similar gold mining funds. As the most reliable harbinger of upcoming inflation and growth, this doubling indicates that increased global growth and rising inflation will be the major themes of 2009. Other commodity-share funds have been forming bullish patterns of higher lows, including KOL (coal mining) and more recently RSX (Russian shares). Russia's economy is very heavily based upon commodity production, and therefore the recent relative strength in RSX is similarly signifying that both inflation and growth will be important global themes in 2009.
High-yield corporate bonds have been forming a bullish pattern of higher lows since the first half of December 2008. While obtaining credit is still far from easy, lenders are much more willing and able to supply capital today than had been the case three months ago. Nearly all corporate-bond sectors have been choppily improving over this period of time, as have municipal bonds. As with government bonds, these are primarily traded by institutions and pension funds; the most knowledgeable investors are signaling that the most distressed period has already passed for obtaining borrowed money.
Implied volatility indices including VXO and VIX remain near 50, which is historically more than twice its average level, but which is far below the extreme readings of 80-90 that were seen in October 2008. Investors are becoming so accustomed to falling stock prices that an increasing number of surveys are showing more investors anticipating an additional 25% decline in the stock market than are expecting a 25% increase. This is among the most negative survey results ever recorded, and is in sharp contrast to the outlook in 1999-2000 when investors routinely anticipated annualized gains of 30% lasting for a decade or more. When so many average participants are gloomy, the only possible resolution is a powerful worldwide equity rally.
As a result of these and similar positive divergences, I am anticipating that the next half year will experience the most dramatic short-term global equity rally since the Great Depression.
FINALLY, A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, and then again on February 25, 2008 (page M14) and June 2, 2008 (page 41), as well as August 25, 2008 (page 32).
CURRENT ASSET ALLOCATION (fully marked to market on August 25, 2009): My own personal funds are currently allocated as follows: LONG POSITIONS: Gold mining funds GDX, ASA, BGEIX, INIVX, 36.1%; Volatility fund VXX, 9.1%; U.S. Treasury fund TLT, 8.3%; Coal mining fund KOL, 7.4%; Japanese smallcap funds DFJ, SCJ, JSC, JOF, SPJSX, 7.2%; Global equity fund VIDMX, 6.6%; Energy closed-end fund PEO, 5.2%; Russian fund RSX, 3.6%; General-equity closed-end funds ADX, CET, 3.1%; Natural-gas futures fund UNG, 2.7%; High-yield BB corporate bond fund VWEHX, 1.7%; Natural-gas fund FCG, 1.7%; Crude-oil futures fund USO, 0.7%; Municipal bond fund MYJ, 0.0% (just sold); VINIX, 0.2%; VIEIX, 0.2%; TRBCX, 0.2%; KRE, 0.2%; XRT, 0.2%; VZ, 0.2%; TRI, 1.5% (bought at a 15% discount); gold and silver coins and related metals collectibles, 3.3%; other collectibles, 0.3%; Vanguard Municipal Money Market Fund VMSXX, 0.2%; Putnam Stable Value Fund (retirement fund with stable principal paying variable interest), 0.1%; SHORT POSITIONS: None; covered ALL of them in October 2008 which had amounted to just over half of my entire net worth.
REMINISCENCE OF THE WEEK (August 25, 2009): A few years ago, my wife and I decided to take a vacation in Harpers Ferry, West Virginia. We selected a charming bed and breakfast run by Jim Addy and his wife, which had received strongly favorable reviews on several internet web sites. As we walked through the small, hilly city on our first day, we noticed a high frequency of political signs on many lawns: "Re-Elect Jim Addy, Mayor". As the bed-and-breakfast host was graciously pouring our tea the next morning, I asked him, "Am I being served by the mayor of this fine city?" "Indeed you are!" he replied. "We intentionally don't mention that fact in our advertising." By another odd coincidence, his wife had been my brother's English teacher at Baltimore Polytechnic High School before she retired. Unfortunately, whether due to the responsibilities of being mayor or for personal reasons, this bed and breakfast is no longer in business. I see that Jim Addy has invited President Obama to attend that city's 150th anniversary of John Brown's Raid which helped to start the U.S. Civil War.
(c) 1996-2009 Steven Jon Kaplan Your comments are always welcome.